The Consumer Price Index (CPI) Made Simple

Wealth Daily Research Team

Posted May 8, 2023

Have you seen the term consumer price index or CPI report recently and been confused?

Or do you ever wonder why everyday things like food, clothes, and gas cost what they do? Well, you’ve come to the right place. In this article, we will go over everything you need to know about the consumer price index (CPI). 

Understanding the Consumer Price Index (CPI)

What Is the CPI?

The consumer price index (CPI) is a way to measure how much the prices of things like food, clothes, and gas change over time. 

It looks at how much money people spend on these things and then calculates an average. CPI helps us see how expensive things are getting and how that affects our lives.

Prices can rise due to many factors. Changes in government policy, supply and demand, production cost increases, and inflation are usually the main reasons for price increases. 

The consumer price index (CPI) is often used as a measure of inflation, as it tracks the changes in the prices of a basket of goods and services over time. Inflation refers to the general increase in the prices of goods and services in an economy over time. 

When the CPI goes up, it indicates that the cost of living is increasing, and this is often seen as a sign of inflation.

Why Is the CPI Important?

The CPI is important because it helps us understand how much prices have changed over time and how those changes impact the cost of living. For example, if the CPI goes up 2% in a year, that means the cost of living has increased by 2%. 

This information can be used by the government, businesses, and individuals to make important economic decisions, such as setting interest rates, adjusting wages and benefits, and planning for retirement.

If the CPI shows prices going up, investors may choose investments that benefit from inflation, like stocks or real estate. However, if the CPI shows prices going down, investors may choose investments that benefit from deflation, like bonds.

How Is the CPI Calculated?

The CPI is calculated by the Bureau of Labor Statistics (BLS), which is part of the U.S. Department of Labor. The BLS collects data on prices from thousands of retail stores, service establishments, and housing units across the country. 

The prices are weighted based on how much of the item people typically buy. For example, if people spend more on housing than on clothing, housing prices will have a larger weight in the calculation.

The BLS also updates the CPI to reflect changes in the basket of goods and services over time. For example, if people start spending more on smartphones and less on landline telephones, the CPI will be adjusted to reflect that change.

But did you know there is more than just one CPI? 

There are actually several different types of CPI, each with a slightly different focus or methodology. 

The Main Types of Consumer Price Indexes:

  • CPI-U: This is the most widely used measure of the consumer price index in the United States. It represents the prices paid by all urban consumers, including both wage earners and non-wage earners.

  • CPI-W: This measure of the consumer price index represents the prices paid by urban wage earners and clerical workers. It is used to calculate cost-of-living adjustments for Social Security and other government benefits.

  • CPI-E: This measure of the consumer price index is designed to reflect the spending patterns of Americans aged 62 and older. It includes more spending on items such as health care and housing, which are typically more important to older Americans.

  • CPI-M: This measure of the consumer price index represents the prices paid by people living in metropolitan areas. It is used to provide a more detailed look at how prices are changing in urban areas.

  • Chained CPI: This measure of the consumer price index takes into account changes in consumer behavior as prices change. For example, if the price of beef goes up, consumers may switch to chicken instead. The chained CPI reflects this substitution effect.

Each type of CPI has its own strengths and weaknesses and is used for different purposes. However, they all aim to provide a measure of how prices are changing over time and how those changes impact the cost of living for different groups of people.

What Does the CPI Tell Us?

The CPI tells us how much prices have changed over time, but it also provides information on which items have gone up or down in price. 

The BLS publishes monthly reports that show the percentage change in the CPI from the previous month and the previous year, as well as a breakdown of the price changes for different categories of goods and services.

If the price of gasoline goes up, that will be reflected in the CPI. If the price of clothing goes down, that will also be reflected in the CPI. By looking at the breakdown of price changes, we can see which items are contributing the most to changes in the overall CPI.

What Are Some Criticisms of the CPI?

While the CPI is an important tool for tracking changes in the cost of living, it is not without its critics. One criticism is that the basket of goods and services used to calculate the CPI may not accurately reflect the spending habits of all consumers. 

For example, some people may spend more on health care or education than the average person, and those items may not be weighted as heavily in the calculation.

Another criticism is that the CPI may not fully capture changes in quality over time. A new smartphone may cost the same as an old one, but it may have more features and better performance. This improvement in quality may not be reflected in the CPI.

Using the CPI 

The consumer price index is an important tool for tracking changes in the cost of living over time. It helps us understand how prices are changing for different goods and services and how those changes impact our daily lives. 

While the CPI is not perfect, it provides valuable information for individuals, businesses, and governments to make informed decisions about the economy.

To get a better handle on the consumer price index and how to invest in companies to protect yourself from inflation, make sure to subscribe to Wealth Daily. Our community of experts and investors has one goal in mind: building wealth. Once you are subscribed we encourage you to view the latest investment opportunities that we believe could treat investors very well.

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